Taxation of Estates and Gifts

Gift Tax

26 U.S.C. § 2501 imposes a gift tax on "transfers of property by gift."

Taxable Gifts

Start with the total amount of gifts made during the year. 26 U.S.C. § 25.2511-2.

Then exclude all medical and educational expenses. 26 U.S.C. § 2503(e).

Tuition of medical expenses must be paid to the providers, not the beneficiary.

Then exclude the annual exclusion amount. 26 U.S.C. § 2503(b).

Then deduct marital gifts. 26 U.S.C. § 2523.

Then deduct charitable gifts. 26 U.S.C. § 2522.

Then add the GST tax payable. 26 U.S.C. § 2515.

The resulting amount is "taxable gifts".

Then calculate the tax due by:

Combining the amount of taxable gifts in the current year with the taxable gifts of all prior years.
Calculate how much the tax would be on that amount.
Calculate how much the tax would be on just the prior years'.
Subtract the amounts.
Subtract the available gift tax credit.

The remaining amount is the gift tax due.

The gift tax applies to real, personal, and intangible property. 26 U.S.C. § 2511.

The value of the gift is what a willing buyer would pay a willing seller. 26 U.S.C. § 25.2512-1.

Any inadequate consideration paid by the donee can be deducted from the value.

Married couples can split gifts to treat them as being made half by each, but consent must be signified by Tax Day (usually done on the gift tax return).

Not needed in community property states for obvious reasons

Annual Exclusion

The first $10,000 (adjusted for inflation, so $15,000 in 2019) of gifts can be excluded per donee per year. 26 U.S.C. § 2503(b)(1).

Gifts of future interests are denied the annual exclusion. Only present interests qualify. 26 U.S.C. § 2503(b)(1).

Income from a discretionary trust does not qualify for the annual exclusion because the beneficiaries thereof do not have a present interest then. 26 CFR § 25.2503-3(c)

If the settlor retains the right to withhold the money, each individual distribution uses the annual exclusion for that year. 26 CFR § 25.2511-2(b)–(c).
If the trustee has the discretion to decide the portions among the beneficiaries, they still have no present interest. The entire amount will be included in that year's taxable gifts, and there're no annual exclusions in the distribution years.
- It's still irrevocable, so you still have to pay the taxes. It's just discretionary so you don't get the deductions.

Marital Gift

Outright gifts to spouses qualify for a marital exception. 26 U.S.C. § 2523(a).

Gifts of terminable interests do not qualify. 26 U.S.C. § 2523(b).

If the spouse's interest is terminable—don't get confused by others' terminable interests.

Future interests are OK.

Generation-Skipping Transfer

A generation-skipping transfer, where one gives to his grandchild, is subject to a GST tax. 26 U.S.C. § 2601.

A GST is a taxable distribution, taxable termination, or direct skip.

Direct Skip

A direct skip is a transfer subject to a gift or estate tax that is made to a skip person.

This includes distributions from revocable trusts where the settlor has to include them as gifts.

Direct Skip Nontaxable Gift

A transfer excluded from gift tax by the annual exclusion amount or by medical/education exclusions is also excluded from the GST tax. 26 U.S.C. § 2642(c).

Skip Person

A skip person is an individual two or more generations below the the transferor. 26 U.S.C. § 2613(a)(1).

If someone is not a descendent of the transferor's grandparents, he is assigned two generations below the transferor if he was born more than 37½ years after the transferor was. 26 U.S.C. § 2651(d).
- However, if one has been married at any time to the transferor or a non-skip relative of the transferor, he is assigned the same generation as the transferor and is not a skip person. 26 U.S.C. § 2651(c).
- Or if one is the descendant of a transferor's spouse's or former spouse's grandparents, he is not a skip person if he is not two generations or more below the spouse. 26 U.S.C. § 2651(c).

A trust also counts as a skip person if all interests are held by skip people. 26 U.S.C. § 2613(a)(2).

Entities are treated as being owned by the individuals owning them. 26 U.S.C. § 2651(f)(2).

Interest

A skip person has an interest in a trust if he can receive current distributions of income or principal. 26 U.S.C. § 2612(c).

This is different that what is a "present interest" for annual exclusion purposes.

There are three types of taxed GSTs:

Direct Skip
A direct skip is a transfer subject to a gift or estate tax that is made to a skip person.
- This includes distributions from revocable trusts where the settlor has to include them as gifts.
Direct Skip Nontaxable Gift
A transfer excluded from gift tax by the annual exclusion amount or by medical/education exclusions is also excluded from the GST tax. 26 U.S.C. § 2642(c).

DSNG Separate Share Rule
A transfer to trust does not qualify as a DSNG however unless it is distributable only to that individual during his life and the trust assets will be includable in that individual's federal gross estate if he dies before the trust terminates. 26 U.S.C. § 2542(c)(2)(A)–(B).

Just because a transfer to trust is eligible for for the annual exclusion amount does not mean that it is a DSNG.
Taxable Termination
A termination of an interest in a trust is a taxable termination if it leaves only skip persons as beneficiaries of the trust.

A generation-skipping transfer tax is imposed when a taxable termination occurs.
Taxable Distribution
A taxable distribution is a distribution from a trust to a skip person that is not a taxable termination or a direct skip. 26 U.S.C. § 2612(b).

E.g., distributions from an irrevocable trust.

GSTs are always taxed at 40%. 26 U.S.C. § 2641; 26 U.S.C. § 2001(c).

GST taxes are paid out of the property constituting the GST unless explicitly stated otherwise. 26 U.S.C. § 2603(b).

It has to specifically say GST. Even saying "all taxes" is not enough to rebut the presumption.
If a GST is a taxable distribution, the GST tax is paid by the transferee, presumably out of the distribution. 26 U.S.C. § 2603(a)(1).

If you only know the amount including taxes with direct skips, divide the amount by 1.4 to find the after-tax amount given, and multiply that by .4 to find the amount of the GST tax.

Direct skips are more efficient because you don't have to pay GST taxes on the GST taxes, only on what the transferee receives. 26 U.S.C. § 2623. Taxable terminations and taxable distributions do have to pay GST taxes on the GST taxes. 26 U.S.C. § 2621; 26 U.S.C. § 2622.
For taxable distributions or taxable terminations with the taxes paid out of another source, multiply the amount given by two-thirds to get the tax amount. (.4 ÷ .6)

Gift tax has to be paid on GST tax amounts.

Gift tax does not have to be paid on gift tax amounts. So don't keep adding it up forever, just once.